United States: Incorporating Your Practice: A Guide To "Why" And "How" For New Health Care Professionals

The medical* and dental professions unquestionably combine challenge and reward in ways few other careers can. The educational and internship issues doctors have faced by the time they begin practicing professionally are significant, and they may have gone through some financial hardship as well. As a result, those who are opening or acquiring a practice want to make sure they set it up to maximize their financial well-being and capitalize most effectively on their hard work. To that end, the question of incorporation always enters the picture.

Whether to incorporate or not, however, is only one of a dizzying multitude of concerns new doctors and dentists have to deal with. And the decision is not always simple. While there are, unquestionably, significant financial benefits to incorporating a medical or dental practice, there are also a few potential drawbacks you should consider. Moreover, there are certain aspects—around tax and insurance, for example—that you may not have considered, but that should be understood and taken into account with respect to your specific goals and situation.

This guide is designed to take some of the pain out of the incorporation decision making process for newer medical and dental professionals who are dealing with a host of other issues related to launching a career. It will focus on whether incorporation is an appropriate option for you, the steps involved should you decide to go ahead, and what you'll have to think about once your corporation is established and functioning.

The big question: Should I incorporate?

Incorporation is a big step. It will change the nature of your practice and have long-term implications for you and your family, many of which can be highly beneficial. But is it the right step for you? Consider the following pros and cons as you make the determination:

Tax deferral

In most cases, as soon as doctors or dentists begin work, they will be at the high end of the wage earning scale. This means that, if they take no steps and pay taxes at their personal marginal rate, significant earnings will be taxed at a very high rate. Clearly, finding ways to pay less tax and defer tax will be a key financial planning strategy, and incorporation can be an excellent way to do it.

When you create a professional corporation, practice assets are transferred to the corporation and you become a shareholder and may also become an employee (as opposed to a proprietor) whose salary is paid by the corporation. The immediate benefit is that professional corporations, via the small business deduction (SBD), pay less tax— substantially less than the personal income tax rates paid by individuals. The legislation proposed in the 2016 federal budget will restrict the ability for some professional corporations to claim the small business deduction, depending on how the professional corporation operates within the overall corporate structure. Please consult with an advisor to determine if this impacts your business.

If you are in a situation where your personal cash needs are less than your earnings potential, you can leave money in the corporation where it will be taxed at the lower corporate rate. Not only will you then have more after-tax money to invest in the corporation, but when you do eventually retire and withdraw it, you will pay less tax on it as your personal income level will presumably be lower. This step may not only bring retirement closer, but will ensure it's better funded. In addition to retirement savings, tax savings could be considerable in the short term by utilizing corporate retained earnings to fund a sabbatical, a maternity/paternity leave or simply taking extended periods of time off. Remember though, if you are not able to retain enough earnings in the corporation, the cost of operating it may not be justified by the tax benefits.

Income splitting

Do you have a spouse who has no income or earns significantly less than you do? If so, the possibility of income splitting is another advantage of incorporation. By making your spouse a shareholder in the corporation (permitted in most provinces) you can split your income with them by paying them corporate dividends—which will then be taxed at their lower personal rate. You can use those dividends to ensure you and your spouse have similar income levels, thereby maximizing both of your marginal tax brackets.

If you have children, there are also ways to income split with them. They can be made a shareholder of your corporation but under specific rules, you are unable to income split with them until they turn 18. Once they turn 18, they can be paid dividends that would be, again, taxed at their lower marginal rate. If you don't wish to put shares directly into their hands, you can create a family trust of which your child or children would be the beneficiaries, letting you allocate discretionary funds to them each year as required to maximize your income splitting opportunities.

Paying a salary to your spouse or children from the corporation is another possible income splitting strategy, but be careful, as the salary must be "reasonable." By "reasonable," the amount must be equivalent to what you would pay a third party for the same level of work. Dividends, on the other hand, do not need to meet the definition of reasonable as dividends are a form of investment income.

Increased complexity, higher administrative costs

One of the potential drawbacks of incorporation is that you will have a more complex business structure with higher administrative costs.

Some of the added complexities are:

  • As a separate, distinct business and financial entity, the corporation will need separate corporate bank accounts, corporate credit cards, etc.
  • Accounting is more rigid and regulated in a corporate scenario.
  • You will have to make additional filings, including:
    • a corporate tax return and
    • T4/T5 slips to report salary or dividends.
  • There is also a cost to the act of incorporation itself.

Ultimately, you must weigh these increased costs against the potential benefits of tax deferral and/or income splitting to determine the value incorporation may offer to you.

Creditor protection

Creditor protection is another issue you may want to consider. Look at creating a separate holding company where you can invest excess funds not required for personal spending to protect them from your corporation's creditors. This does, of course, further escalate administrative costs and complexity. You will also want to weigh whether litigation risk justifies increasing your insurance protection in addition to establishing the holding company.

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